Labor & Employment

Severance Agreements Can Ease the Trauma of Executive Departures

Parting ways with an employee, especially an executive employee, is never easy. But having the proper severance agreements in place can help the process go smoothly.

In a recent online event hosted by Corporate Counsel Business Journal, Charles Bruder, co-chair of the Executive Compensation and Employee Benefits Group at Norris McLaughlin & Marcus, discussed key issues that businesses should consider when an executive employee leaves. The wide-ranging presentation touched on several best practices to keep in mind in drafting a severance agreement.

Bruder said that even in garden-variety cases of voluntary termination of employment, where there is no animosity between the executive and the company, severance agreements can be more complicated than one might think. “In tackling any type of severance arrangement, our starting point typically is to look at the facts and circumstances associated with the termination,” he said. Those insights can then be used to develop a checklist of issues that the company will potentially have to deal with during the proceedings.

First, Bruder said, consider why the individual is leaving the company. If he or she is going to a competing company (as is often the case with executive employees), the separation agreement needs to contain confidentiality provisions, such as non-solicitation and noncompete arrangements. “Confidentiality is going to be key,” Bruder said – not only regarding the circumstances of the individual’s termination, but also with respect to the agreement itself. If the termination is involuntary, the separation agreement is likely to be more complex. At a minimum, it should contain language that demonstrates that the individual was terminated for cause.

Compensation is also a key area of concern – and again, specificity is critical. If the terminated individual is entitled to receive deferred compensation payments, there are rules under Section 409A of the Internal Revenue Code that must be followed. As is often the case with the tax code, things can get tricky. According to Bruder, it’s a good idea to make sure you have satisfied the statutory requirements of that section of the code – and to include those provisions in the separation agreement itself. “We want to avoid any potential ambiguity associated with the arrangement,” he said.

The situation is similar in change-of-control terminations. Often, when there is a change-of-control transaction associated with a company or when the company’s assets or a substantial amount of its stock have been sold, key executives will negotiate a severance package with those assets in mind. Once the agreement has been structured, one of the biggest concerns is the form of the severance payments. Typically, severance payments are made in cash over some specified period of time, but there are other options as well.

Companies should also consider health insurance benefits. Frequently, under federal or state law, terminated individuals will have the right to continue their coverage with the company-sponsored group plan – typically at their own cost. Or the company may agree to cover the costs associated with the health insurance benefits for some specified amount of time.

From there, Bruder turned his attention to the more technical aspects of severance agreements, including the ways in which certain provisions of the Employee Retirement Income Security Act come into play, and a deeper discussion of the provisions of Section 409A of the Internal Revenue Code. “A failure to satisfy these requirements,” he warned, “results in a couple of potentially nasty financial liabilities.”

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